Guide to Project Finance

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A guide to project finance

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Energy, Transport & InfrastructureFinancial InstitutionsReal Estate & RetailTechnology, Media & Telecoms


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Denton Wilde Sapte International Projects Group

Personnel

Denton Wilde Sapte has over 50 years experience in providing legal services to projects. With over 60lawyers working on projects around the world, we have one of the largest projects practices in Europe,Middle East and Africa. We advise parties on all sides of projects, including banks, project sponsors,governments, government agencies, regulators, export credit agencies, multilateral agencies and insurancecompanies.

We have experts who work exclusively in each of the following sectors:

oil and gas, including liquefied natural gas

petrochemicals

electricity

mining and natural resources

roads

rail

water

aviation and shipping

telecommunications.

One of the key distinguishing features of our Projects practice is that many of our lawyers have previouslyworked in industry and therefore have a detailed knowledge and understanding of their specialist industry.

International coverage

Projects are managed from each of our offices in London, Dubai, Paris, Moscow and Almaty.

Key contactsFor further information please contact:

Christopher McGee Osborne or Howard Barrie in our London office on +44 20 7242 1212

Neil Cuthbert in our Dubai office on +971 4 331 0220

Doran Doeh in our Moscow office on +7 952 557 900

Sena Agbayissah in our Paris office on +33 1 5305 1600

Marla Valdez in our Almaty office on +7 3272 581 590

Contacts in our other offices can be obtained from any of the above offices.

A GUIDE TO PROJECT FINANCE DENTON WILDE SAPTE


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Foreword

Since the last edition of this guide in 2000, the use of project financing techniques as a means of financing largescale infrastructure projects has continued to be popular, although in some of the countries that werepreviously strong supporters of such techniques its popularity has waned. In their place, new markets havecome to the fore.

Project financing techniques continue to enjoy popularity in certain regions in Europe. Major infrastructure,

defence and public spending public-private partnerships (PPPs) have closed successfully in Britain, and the EUcontinues to endorse the model for major infrastructure needs. The Spanish project finance market has beenactive since 1993. Despite some doubts about the performance of some projects previously and theuncertainties arising from the draft Basel II Accord, the market is strong and growing. Spain is making progresswith new PPP legislation but is at the moment exercising caution in its approach to PPPs. In the last few years,two large IPPs were financed in Spain.

2003 has been a frustrating year for PPPs in Germany. However, on the other hand, the Netherlands is one ofEuropes frontrunners in developing PPPs. The PPP market in Italy has not developed much more than theGerman market. Part of the problem, which Italy shares with Germany, is the fact that all PPP projects requiremunicipal, regional and national approval in a highly politicised environment. In Italy, IPPs have been prevalentand severe power shortages in the recent past suggest future investment, especially in the south. Rail, airportand bridge projects are likely to follow.

In the Republic of Ireland investment in infrastructure became a major priority in the Irish Governmentsprogramme, and good progress has been made. Irelands PPP process began three years ago with eight pilotprojects, and now there are almost 40 at various stages of procurement across a range of sectors, includingroads, rail, housing, schools, and environmental services.

The French project finance market is evolving towards envisaging private sector participation in the financing ofinfrastructure in the areas of independent power projects (IPPs) and toll roads. However, it appears that France isstill not ready for UK-style private finance initiative (PFI) in areas such as schools and prisons. In France, the rapidexpansion of the use of PPPs in sectors such as health, police and justice is more likely. The Turkish projectfinance market also continues to be encouraging whilst Greece has recently closed its first IPP.

Over the past five years, the Middle East region1 has become an oasis of project finance opportunity. Lendershave closed an estimated US$27 billion in project loans in the past few years, with another US$54 billion of

loans in various stages of development or financing. Expanding regional populations, macroeconomic growthand a rising demand for services are driving the market. As the legal, business and regulatory environments inthe region continue to develop and improve, the world financial community is becoming more interested infinancing projects in the Middle East. Project finance remains a viable and effective means of financinginfrastructure in the Middle East, particularly in the water, power, oil and gas sectors. Moreover, in the Gulf,Islamically- structured project finance is becoming more usual, providing an additional source of liquidity to theconventional bank market. A number of major project finance deals have successfully included an Islamictranche, including the Shuweihat IWPP, Umm al-Nar IWPP, Aluminium Bahrain (ALBA) Potline 5 and Equatepetrochemical project, to name but a few.

It is significant that there has been a major reduction in project finance volumes in South America since 1997.This reduction could be associated with several macroeconomic events like the Russian crisis in 1998 or theArgentinean default in 2001. Such events have slowed down regional growth from the 4-5 per cent range in themid-90s to a marginal growth rate of 1.5-2 per cent in the past five years. However, despite the setbacksmentioned one can remain positive regarding the prospects for the South American infrastructure sector in thecoming years for several reasons, one such reason being the need for investment in the range of $40-50 billionper year in the infrastructure sector to sustain a regional growth of 3.5-4 per cent. Such investment will need tobe financed (approximately) 70 per cent by the private sector and 30 per cent by the public sector.

While international lenders remain wary of increasing their exposure to most countries across South America,Mexico and Chile are exceptions. With the help of multilateral and ECA support many smaller projects aremoving forward, while others are turning to local banks and the domestic capital markets for financing. Chileremains a favoured country for lenders and foreign institutional investors because of its sovereign single Arating. Chile also has upcoming PPP projects in areas such as prisons, commuter rail, reservoirs, water treatmentfacilities and more airports. Substantial funding is going to be required for the Chilean toll road sector over thenext 12 months, with over $1 billion needed on four major toll road projects in Santiago, in addition to a rangeof smaller deals across the country. In Latin America, mining companies are using project financing techniques

to fund their mining development and reduce company debt and shareholder exposure. PPP is a veryinteresting concept for countries like Brazil which require huge investments in projects, but, on the other hand,are endeavouring to eliminate budgetary deficits and have a high level of public indebtedness. Brazil providesseveral opportunities for investments by the private sector, in different areas like energy, telecommunications, oil


1 For the purposes of this foreword, theMiddle East region includes the areafrom North Africa to the Gulf region (i.e.Morocco, Algeria, Libya, Egypt, Lebanon,Syria, Jordan, Israel, the Gaza Strip, Saudi

Arabia, Iran, Iraq, Kuwait, Qatar, Bahrain,Yemen, Oman and the United ArabEmirates).


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and gas, transportation systems, water and sewerage services, chemical and petrochemical industries, amongothers. Many project finance transactions have been successfully implemented in Brazil. Furthermore, a series ofground breaking oil and gas projects in Brazil, Peru and Mexico are likely to lead to an increase of project financein South America in the oil and gas sectors.

In the US, the funding for the SR125 toll road project which closed in June 2003, marked the first time that thepublic-private partnership approach was used in the US. With the need for massive infrastructure investments inthe US putting strains on traditional funding methods, with government entities promoting non-traditional

approaches such as PPPs to increase the funding mechanisms available to public authorities, and withinternational project market players looking over to the US for potential projects in which to become involved,more PPP projects could well be on the way. With little interest from US project banks in PPP structures, it is theEuropean banks that look set to take advantage of the burgeoning market despite the loss of confidence inderegulation in the aftermath of the California merchant power crisis and the Enron bankruptcy. The rise ofproject finance in the US seems set to increase despite an initial lack of confidence of the use of project financein the power sector. The long-term effect of the California crisis and the Enron bankruptcy is a greater increasein the financial appeal and valuation of regulated companies serving customers.

In Asia, project finance has resurrected itself, although in a somewhat less robust form than prior to the 1997crisis. Japan was the first Asian country to take up PPP when it introduced its PFI law in 1999. Since 2002 thecentral government, in areas such as government offices, residential facilities and national universities, hasbegun to look more seriously at using PFI-type structures. In late 2002 Taiwan announced its intention tointroduce a PFI model for large scale public capital projects. The Taiwan High Speed Railroad, with an estimatedcost of US$15 billion, is an example of such projects which have benefited from private investment. Variousincentives to encourage private sector participation were outlined in the BOT law passed in 2002. Theinfrastructure demands of Asia remain enormous. Two years before the crisis it was estimated that infrastructureinvestment worth about US$1.5 trillion will be required in East Asia over the period 1995-2004 2.

However, from a country standpoint, some former darlings of project financiers have lost their lustre, includingmost notably China, Indonesia and Vietnam. In China, activity in the power sector has stalled due to lack ofstable domestic demand and alleged tariff disputes on earlier IPP projects. Most recent Asian project financetransactions have occurred in countries such as Thailand, Singapore and the Philippines and, to a lesser extent,India. There have been new entrants as well with three complex financings of power projects well underway inBangladesh and Sri Lanka. The SembCorp Cogen financing in Singapore will represent Asias first merchantpower project. It is an exciting development that may be imitated elsewhere in the region. However, theessential pre-conditions to a merchant power market predictable demand, privatisation and de-bundling of

utility assets have not begun to be addressed seriously in many Asian countries.

In South Africa, the need to improve service delivery has been the main driver of PPPs in South Africa. The PPPmarket has developed over time, particularly in the national and provincial spheres but the deal flow has sloweddown recently.

Several factors have contributed to the dramatic growth in project financing. Many countries have sought agreater role for the private sector, including investment areas once seen as the domain of the public sector. Thisshift called for major regulatory reforms, which governments, by and large, rightly embarked on. Encouraged bythe availability of long-term foreign capital and with strong backing for policy reforms from international financialinstitutions, project financing expanded, beginning in Latin America and East Asia. By sector,telecommunications took the lead, with investments amounting to 43 per cent of flows to all infrastructuresectors, while energys share was 36 per cent3. The types of private participation pursued by the leading regionsvaried in interesting ways. In Latin America and Central Asia, divestiture, often accompanied by market structureand regulatory reforms, was widely preferred. In contrast, East and South Asia chose greenfield investments - forexample, bulk supply facilities by independent power producers.

Traditionally, developing countries have benefited from project finance as a tool for financing power, mining, oil,and gas projects. But project finance applications have broadened over the years to include not just greenfieldprojects in the hard sectors, but also soft infrastructure projects like water and sewerage. Project finance hasalso been used - albeit in limited ways - in the service sector, such as privately financed hospitals and leisureprojects. In short, where projects can stand on their own and where the risks can be identified up-front, privatefunding through project finance offers potential. Without doubt, project finance is alive and well.

Neil CuthbertDenton Wilde Sapte

DENTONWILDE SAPTE A GUIDETO PROJECTFINANCE

2 World Bank, Infrastructure Development inEast Asia and the Pacific. Towards a NewPublic Private Partnership, 1995.

3 World Bank, PPI Project Database.


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Contents

1 SECTION 1 INTRODUCTION

1 1.1 Origins of project financing

2 1.2 Definition of project finance

3 1.3 Extent of recourse

4 1.4 Why choose project finance?

5 1.5 Structuring the project vehicle6 1.6 Key sponsor issues

7 1.7 Project implementation and management

9 SECTION 2 PARTIES TO A PROJECT FINANCING9 2.1 Parties and their roles

9 2.2 Project company/borrower

10 2.3 Sponsors/shareholders

11 2.4 Third-party equity

11 2.5 Banks

12 2.6 Facility agent

12 2.7 Technical bank

12 2.8 Insurance bank/account bank

12 2.9 Multilateral and export credit agencies13 2.10 Construction company

13 2.11 Operator

13 2.12 Experts

14 2.13 Host government

14 2.14 Suppliers

14 2.15 Purchasers

14 2.16 Insurers

15 2.17 Other parties

15 2.18 Summary of key lenders concerns

17 SECTION 3 PROJECT FINANCING DOCUMENTATION17 3.1 Role of documentation

17 3.2 Shareholder/sponsor documentation

18 3.3 Loan and security documentation20 3.4 Project documents

24 3.5 Force majeure

26 3.6 Lender requirements for project documents

29 SECTION 4 PROJECT STRUCTURES29 4.1 Approach to financing

29 4.2 Bonds

30 4.3 Leasing

31 4.4 North Sea model

31 4.5 Borrowing Base model

32 4.6 Build Operate Transfer BOT model

35 4.7 Forward Purchase model

37 4.8 The UK PFI model

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39 SECTION 5 SHARING OF RISKS39 5.1 Identification and allocation of risks

39 5.2 Ground rules

40 5.3 Categories of project risks

47 SECTION 6 SECURITY FOR PROJECTS47 6.1 Approach of lenders

47 6.2 Reasons for taking security

48 6.3 Universal security interests49 6.4 Scope of security

51 6.5 Third party security

53 6.6 Direct agreements

56 6.7 Host government support

56 6.8 Comfort letters

57 6.9 Governing law

57 6.10 Security trusts

58 6.11 Formalities

58 6.12 Problem areas

59 SECTION 7 INSURANCE ISSUES59 7.1 Role of project insurances

59 7.2 Who insures?

59 7.3 Scope of cover

59 7.4 Problem areas

60 7.5 Protection for lenders

61 7.6 Brokers undertaking

62 7.7 Reinsurance

63 SECTION 8 THE PROJECT LOAN AGREEMENT63 8.1 Warrant ies, covenants and events of default

65 8.2 Project bank accounts

65 8.3 Appointment of experts

66 8.4 Information and access

67 8.5 Cover ratios

69 8.6 Governing law and jurisdiction

70 8.7 Completion issues

71 SECTION 9 UNITED KINGDOM PRIVATE FINANCE INITIATIVE PROJECTSUnited Kingdom PFI/PPP Projects

71 9.1 Background

71 9.2 Key features of PFI/PPP contracts

72 9.3 Parties

72 9.4 Project contracts

73 9.5 Tendering process

74 9.6 PFI/PPP contracts and the OGC on Standardisation of PFI Contracts

78 9.7 Transfer of interests in land

79 9.8 Local authority powers and the Local Government (Contracts) Act 1997

81 SECTION 10 EXPORT CREDIT AGENCIES AND MULTILATERAL AGENCIES81 10.1 The role of export credit agencies in project finance

81 10.2 An introduction to the G7 ECAs

81 10.3 The advantages of involving ECAs in a project

82 10.4 The OECD consensus

83 10.5 Departing from consensus

83 10.6 Categories of ECA support in the context of a project financing

87 10.7 The changing role of the ECA in project finance

87 10.8 ECAs and credit documentation

88 10.9 Multilateral agencies

88 10.10 World Bank Group

92 10.11 European Bank for Reconstruction and Development (EBRD)

92 10.12 European Investment Bank (EIB)

92 10.13 Asian Development Bank (ADB)

92 10.14 Commonwealth Development Corporation Group Plc (CDC Group Plc)93 10.15 Intercreditor issues in multi-source project finance

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GLOSSARY OF TERMS

Bond A negotiable note or certificate evidencing indebtedness of the issuer tothe holder.

BOT Project A project structure involving (usually) a concession granted by agovernment (or government entity) under which a facility or project is built,owned and operated by the project company and (usually) transferred back

to the government at the end of the concession period.

Comfort Letter A letter issued by one person to another pursuant to which the issuermakes certain statements (usually not legally enforceable) concerning afacility, project or company.

Concession Agreement An agreement (sometimes called a licence or lease) under which thegrantor confers on the project company the right for an agreed period toexploit, develop, construct and operate for a profit a facility or project.

Convertible Currency A currency that can be converted into another currency without the needfor prior authorisation from, or restrictions imposed by, the governingmonetary authority.

Cover Ratios The ratio of a projects discounted cash flow over a particular period(s) overthe amount of project debt at a specified time(s).

Debenture Another name for a fixed and floating charge over all of a companys assets,business and undertaking.

Direct Agreement An agreement entered into between (usually) the trustee/agent of thelenders and a party contracting with the project company pursuant towhich that party gives certain consents, rights and undertakings to thelenders (e.g. consent to lenders security and the right to cure any defaultsof the project company).

Derivative An instrument whose return is linked to, or derived from, another

instrument such as a bond, stock, commodity or other asset.

Export Credit The agency of a country that is established for the purposes ofAgency or ECA providing financial assistance to exporters of that country.

Finance Lease A lease of plant or equipment by a financier to a lessee under whichsubstantially all the risks and rewards of ownership are transferred to thelessee and the lessee is effectively paying, by way of rental, the financierscapital outlay and a return on its capital.

Financial Close The date when all documentary and other conditions precedent to firstdrawing under a project loan agreement are satisfied or waived.

Floating Charge A security that is the creature of many common law jurisdictions under

which the chargor grants the creditor a charge over (usually) all of its assetsand undertaking. The principal characteristic of a floating charge is that itdoes not crystallise into a fixed charge until the occurrence of a particularevent and until crystallisation the chargor can deal with the charged assetsin the ordinary course of its business.

Forward Purchase An agreement under which the lender will agree to purchaseAgreement products from a project company and will make an advance payment for

those products to the project company.

Hedging Instrument An agreement under which a persons currency or commodity or interestrate exposure is covered or offset with another person for an agreed periodof time.

Host Country The government of the country in which a particular facility or project islocated.



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Joint Operating An agreement between two or more persons regulating theirAgreement or JOA respective rights and obligations under a joint venture.

Joint Venture An arrangement between two or more persons set up for the purposes ofundertaking jointly a commercial venture and being an arrangement whichis not a partnership.

Limited/Non Expressions used to define the extent of rights of recourse and

Recourse remedies that a lender will have against a project company or sponsor -usually only against a particular projects assets.

Limited Partnership A partnership consisting of one or more general partners and one or morelimited partners. General partners are jointly and severally liable for thedebts of the partnership on an unlimited basis, whereas limited partnersliabilities are generally fixed by reference to their capital contribution.

Loan Life The ratio of a projects discounted cash flow from the dateCover Ratio of measurement up to the final loan maturity date to the amount of project

debt at a specified date(s).

Multilateral Agencies Agencies jointly set up or established by a group of countries for thepurposes of promoting international or regional trade and economic co-operation, e.g. the World Bank, IFC, Asian Development Bank, EBRD.

Offtake Agreement An agreement under which the product of a facility or projectand Offtake is acquired by a third party (the offtaker), e.g. a Power Purchase Agreement

or Take-or-Pay Agreement.

Operating Lease A lease of plant or equipment by a lessor to a lessee under which thelessee pays rent for the actual use of the plant or equipment, which isnormally for a period less than the useful economic life of the plant orequipment; thus a lessor retains most of the risks and rewards ofownership, including the residual value risk at the end of the lease.

Partnership A vehicle (whether or not incorporated) through which two or more

persons conduct a business venture for profit and agree to share profitsand losses of that venture.

Performance Bond A bond (guarantee) given by one person (usually a bank or insurancecompany) to secure (by means of payment not performance) all or anagreed part of another persons obligations under a contract, e.g.contractors obligations under a Construction Contract.

Present Value The current value of a future stream of cash flows - this is achieved byapplying a discount factor to those future cash flows.

Private Finance An initiative of the UK Government under which the provisionInitiative or PFI of certain public services, together with many of the associated risks of

providing those services, as well as the funding requirements risks aretransferred to the private sector (sometimes now referred to as PPP).

Production Payment A right to an agreed share of the future production of (usually)hydrocarbons or minerals from a facility or project in exchange for anagreed price.

Project Life The ratio of a projects discounted cash flow from the date ofCover Ratio measurement up to the end of the projects useful/economic life to the

amount of project debt at a specified time(s).

Security Trustee/Agent A person (usually a trust company or bank) appointed by the lenders tohold on their behalf security in connection with a project.

Special Purpose A vehicle (usually a limited company or a limited partnership)Vehicle or SPV establ ished solely for the purposes of a particular facil ity or project.

Sponsor A person who is involved (often with others) in originating and structuring a



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project and who will (usually) be a shareholder or owner of all or a part ofthe facility or project.

Supply-or-Pay A contract under which a supplier agrees to supply a service, productContract or raw material to a facility or project for an agreed period and price and to

pay an agreed sum to the counterparty should the supplier be unable tocontinue to supply.

Take-or-Pay Contract A contract under which a buyer agrees to take a service, product or rawmaterial from a facility or project for an agreed period and price and to payan agreed sum to the counterparty should the buyer be unable to continueto buy.

Through-put Contract An agreement under which one party (the shipper) agrees to ship anagreed quantity of (usually) hydrocarbons through a facility such as apipeline usually on a ship-or-pay basis.

Turnkey Construction A construction contract under which the contractor assumesContract responsibility for the design, procurement, construction and commissioning

of a facility or project.

.


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SECTION 1INTRODUCTION

1.1 Origins of project financing

With the explosion of project financing in the late 1980s and 1990s, both in Europe and around the rest ofthe world, there is a temptation to think that the financing of projects on limited or non-recourse terms is arelatively novel concept, and one for which the ingenious lawyers and bankers of the 1980s can take mostof the credit. This is, however, far from being true. Indeed, there is early evidence of project financing

techniques being actively used during Roman times and earlier still. According to the historians, seavoyages on the Mediterranean ocean were extremely dangerous adventures in Greek and Roman times,mostly on account of the dual perils of storms and pirates. As a result of these nautical perils, some riskaverse merchants would take out a fenus nauticum (sea loan) with a local lender with a view to sharing withthat lender the risk of a particular voyage. The fenus nauticum worked on the basis that the loan wasadvanced to the merchant for the purpose of purchasing goods on the outward voyage, which loan wouldbe repayable out of the proceeds of the sale of these goods (or more likely other goods bought overseaswith these proceeds). If the ship did not arrive safely at the home port with the cargo in question on boardthen, according to the terms of the fenus nauticum, the loan was not repayable. At the time this wasviewed essentially as a form of marine insurance, but it can just as easily be classified as an early form oflimited recourse lending, with the lender assuming the risk of the high seas and the perils thataccompanied her. History also recounts that, in order to protect their interests, these brave lenders wouldoften send one of their slaves on the voyage to ensure that the merchant was not tempted to cheat on the

lender (an early ancestor of the security trustee perhaps!).

In modern times too there is plenty of evidence of project financing techniques being used by lenders tofinance projects around the world. In the 19th century lenders in the City of London were financingnumerous railway and other projects in South America and India and investing in other overseas ventureshaving many features of modern day limited recourse lending. In most cases these loans were notspecifically structured as limited recourse loans as we know them today, but the commercial reality wasthat this is exactly what they were.

However, limited recourse lending in the United Kingdom really took off in the early 1970s when lenders inthe United Kingdom started making project finance available for the development of some of the early oiland gas fields in the United Kingdom Continental Shelf. The early projects that were financed on this basiswere relatively few and far between as there was a relatively small pool of lenders prepared to financeprojects on this basis. It would also be true to say that the treasurers of many of the companies operating in

the United Kingdom Continental Shelf at this time took some time to appreciate the advantages offinancing projects in this way. The first major financing in the North Sea was in the early 1970s. This wasBritish Petroleums Forties Field, which raised about 1 billion by way of a forward purchase agreement (seesection 4.7 for a description of this structure). Shortly after this transaction two loans were raised by licenceholders in the Piper Field (Occidental Petroleum Corporation and the International Thompson Organisation).Other financings of North Sea hydrocarbon assets followed and by the late 1970s and early 1980s whathad started as a modest number of transactions had turned into a significant volume of project financingsrelated to oil and gas fields, first in the United Kingdom Continental Shelf and then the Danish andNorwegian Continental Shelves.

Much of the documentation and many of the techniques for these early oil and gas transactions wereborrowed from practice in the United States where adventurous bankers had been lending against oil andgas assets for many years. The significant difference in the context of the North Sea, however, was that

bankers were in reality taking significantly more risks in lending against oil and gas assets in the North Sea.Not only were these brave bankers lending against offshore oil and gas assets where the risks wereconsiderably greater (especially in the early days, given the new technology being developed and utilised),but they were also, in some cases, assuming all or part of the development/completion risk. Traditionally, inthe early days of project financing in the United States, loans were against producing onshore assets, whichcarried a far lesser degree of risk. The North Sea was, however, an altogether more hostile and hazardousenvironment.

The 1980s in the United Kingdom saw perhaps the greatest growth spurt in project financing with powerprojects, infrastructure projects, transportation projects and, at the end of that decade, telecommunicationsprojects leading the way. This was continued throughout the 1990s which saw a huge growth in projectfinancing, not only in Europe and the United States but also throughout South-East Asia and farther afield.There is no evidence that the appetite of sponsors and bankers for this activity is waning and, certainly inthe context of the United Kingdom, the Governments Private Finance Initiative (PFI) is showing clear signs

that the boom will continue well into this century.

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1.2 Definition of project finance

There is no universally accepted definition of project finance. A typical definition of project financing mightbe:

The financing of the development or exploitation of a right, natural resource or other asset where the bulkof the financing is to be provided by way of debt and is to be repaid principally out of the assets beingfinanced and their revenues.

Other more sophisticated definitions are used for special purposes; set out at Fig. 1 is an example of adefinition used in a corporate bond issue. This illustrates the aims of the bondholders on the one hand toexclude from the definition any borrowings having a recourse element (since the purpose of the definitionwas to exclude project finance borrowings from the bonds cross default and negative pledge) against theaim of the issuer to catch as wide a range of project-related borrowings.

The overriding aim behind this rather complex definition is to make it clear that the repayment of the loanin question is, essentially, limited to the assets of the project being financed.

It should be noted that this Guide does not cover either ship or aircraft financing although many financingsof ships and aircraft are financed on limited recourse terms and could be said to be project financings. Inmany of these cases the lenders will, directly or indirectly, limit their recourse to the vessel or aircraft itself,

its earnings (including requisition compensation) and its insurances. However, the financing of ships andaircraft is a specialised area and is not within the scope of this Guide. Many of the provisions of this sectionwill, however, apply equally to the financing of ships and aircraft.

Definition of Project Finance borrowing Fig. 1

Project Finance Borrowing means any borrowing to finance a project:

(a) which is made by a single purpose company whose principal assets and business are constitutedby that project and whose liabilities in respect of the borrowing concerned are not directly orindirectly the subject of a guarantee, indemnity or any other form of assurance, undertaking or

support from any member of the [Group] except as expressly referred to in paragraph (b)(iii) belowor

(b) in respect of which the person or persons making such borrowing available to the relevantborrower have no recourse whatsoever to any member of the [Group] for the repayment of orpayment of any sum relating to such borrowing other than:

(i) recourse to the borrower for amounts limited to aggregate cash flow or net cash flow fromsuch project and/or

(ii) recourse to the borrower for the purpose only of enabling amounts to be claimed in respect ofthat borrowing in an enforcement of any security interest given by the borrower over theassets comprised in the project (or given by any shareholder in the borrower over its shares inthe borrower) to secure that borrowing or any recourse referred to in (iii) below, provided that(A) the extent of such recourse to the borrower is limited solely to the amount of anyrecoveries made on any such enforcement, and (B) such person or persons are not entitled, byvirtue of any right or claim arising out of or in connection with such borrowing, to commenceproceedings for the winding up or dissolution of the borrower or to appoint or procure theappointment of any receiver, trustee or similar person or official in respect of the borrower orany of its assets (save for the assets of the subject of such security interest) and/or

(iii) recourse to such borrower generally, or directly or indirectly to a member of the [Group] underany form of completion guarantee, assurance or undertaking, which recourse is limited to aclaim for damages (other than liquidated damages and damages required to be calculated in aspecified way) for breach of any obligation (not being a payment obligation or any obligation toprocure payment by another or an obligation to comply or to procure compliance by anotherwith any financial ratios or other tests of financial condition) by the person against whom such

recourse is available or

(c) which the lender shall have agreed in writing to treat as a project finance borrowing.

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Set out at Fig. 2 is an example of a typical structure for a project using limited recourse finance in a specialpurpose vehicle structure.

1.3 Extent of recourse

The expressions non-recourse finance and limited recourse finance are often used interchangeably with theterm project finance. In strict terms, non-recourse finance is extremely rare and in most project financetransactions there is some (limited) recourse back to the borrower/sponsor beyond the assets that are beingfinanced. As will be seen in section 6, this security may amount to full or partial completion guarantees,undertakings to cover cost overruns or other degrees of support (or comfort) made available by thesponsors/shareholders or others to the lenders.

It may even be that the only tangible form of support that a lender receives over and above the project assets isa right to rescind the project loan agreement with the borrower and/or to claim damages for breach of anyundertakings, representations or warranties given by the borrower in the project loan agreement. Of course,where the borrower is a special purpose vehicle with no assets other than the project assets being financed bythe lenders, then a right to claim damages from the borrower is likely to add little to a claim by the lenders forrecovery of the project loan from the borrower. Further, the right to rescind the project loan agreement is likelymerely to duplicate the acceleration rights of the lenders following the occurrence of an event of defaultcontained in the project loan agreement. However, in those cases where the borrower does have other assets,or the sponsors are prepared to underwrite any claims by the project lenders for damages against the borrower,then a claim for damages for breach of any undertakings, representations or warranties may afford the lenderssome additional recourse.

A claim for damages, however, from a lenders perspective is not the same under English law (and for thatmatter most common law based jurisdictions) as a claim for recovery of a debt under, say, a financial guarantee.This is because a claim for damages is subject to certain common law rules; for example:

the lender must show that the loss was caused by the breach in question

this loss must have been reasonably foreseeable at the time the undertaking or warranty was given and

the lender is in any event under a duty to mitigate its loss.

In other words, a claim for damages against the borrower is an unliquidated claim as opposed to a claim for adebt, which would be a liquidated claim. All that a lender has to show in the case of a liquidated claim is that thedebt was incurred or assumed by the borrower and that it has become due. This is clearly considerably easierthan having to satisfy the common law rules and consequently lenders and their advisers, wherever possible, will

seek to structure arrangements with a view to acquiring liquidated claims against borrowers and otherssupporting the borrowers obligations (this is particularly important for lenders in the context of sponsorcompletion undertakings - see section 6.5).

Special purpose vehicle structure Fig. 2

Contractor Direct

Agreement

DirectAgreement

LoanAgreement

SecurityTrustee

ConstructionContract

Special PurposeVehicle

ShareholdersAgreement

Offtake

Agreements

Offtakers

Shareholder

Shareholder

Lenders

Security

Agreements



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One of the key differences, therefore, between project financing and corporate financing lies in therecourse that the lender has to the assets of the borrower. As the earlier definitions demonstrate, in projectfinancing this recourse is limited to an identifiable pool of assets, whereas in corporate financing the lenderwill have recourse to all the assets of the borrower (to the extent that these assets have not been chargedto other lenders). Indeed, should the borrower fail to pay a debt when due, then, subject to the terms of theloan documentation, the lender would be entitled to petition to wind up the borrower and prove in theliquidation of the borrower on a pari passu basis with all the other unsecured creditors of the borrower. Inthe context of a project financing, however, a lender would only be entitled to this ultimate sanction if the

project vehicle is a special purpose vehicle set up specially for the project being financed. In those caseswhere the project vehicle undertook other activities, then it would look to ring fence the assets associatedwith these activities and in these cases the lender would not ordinarily be entitled to petition to wind up theborrower for non-payment of the project debt. To allow otherwise would be to allow the lender to haverecourse to non-project assets, which would defeat the purpose of structuring the loan on limited or non-recourse terms in the first place.

This principle of limited recourse financing was recognised by the English courts as long ago as 1877 (andpossibly earlier) in the well-known case of Williams v. Hathaway (1877) 6 CH D 544. In this case, a sum ofmoney (the fund) was paid by way of recompense by a railway company to the vicar of a parish and theincumbent of an ecclesiastical district in accordance with an Act of Parliament which authorised the railwaycompany to take a certain church for its purposes. The Act directed, in effect, that the money be applied bythe recipients to provide a new church and parsonage. The recipients of the fund contracted with a builderto build the church and parsonage and the project proceeded. In the event, the cost of the works exceededthe monies in the fund and the builder took legal action to recover the deficiency. Jessel MR, held, inter alia,that it was permissible for a proviso to a covenant to pay to limit the personal liability under the covenant topay without destroying it. Despite the fact that the contractual arrangements were with the individuals whowere for the time being trustees of the fund, it was held that the object [of the contractual instrument] is tobind the fund and not the trustees in their personal capacity.

1.4 Why choose project finance?

Before examining how projects are structured and financed, it is worth asking why sponsors choose projectfinance to fund their projects. Project finance is invariably more expensive than raising corporate funding.Also, and importantly, it takes considerably more time to organise and involves a considerable dedication ofmanagement time and expertise in implementing, monitoring and administering the loan during the life ofthe project. There must, therefore, be compelling reasons for sponsors to choose this route for financing aparticular project.

The following are some of the more obvious reasons why project finance might be chosen:

the sponsors may want to insulate themselves from both the project debt and the risk of any failure ofthe project

a desire on the part of sponsors not to have to consolidate the projects debt on to their own balancesheets. This will, of course, depend on the particular accounting and/or legal requirements applicable toeach sponsor. However, with the trend these days in many countries for a companys balance sheet toreflect substance over form, this is likely to become less of a reason for sponsors to select projectfinance (the implementation in the United Kingdom of the recent accounting standard on Reportingthe Substance of Transactions (FRS 5) is an example of this trend)

there may be a genuine desire on the part of the sponsors to share some of the risk in a large projectwith others. It may be that in the case of some smaller companies their balance sheets are simply notstrong enough to raise the necessary finance to invest in a project on their own and the only way inwhich they can raise the necessary finance is on a project financing basis

a sponsor may be constrained in its ability to borrow the necessary funds for the project, either throughfinancial covenants in its corporate loan documentation or borrowing restrictions in its statutes

where a sponsor is investing in a project with others on a joint venture basis, it can be extremelydifficult to agree a risk-sharing basis for investment acceptable to all the co-sponsors. In such a case,investing through a special purpose vehicle on a limited recourse basis can have significant attractions

there may be tax advantages (e.g. in the form of tax holidays or other tax concessions) in a particularjurisdiction that make financing a project in a particular way very attractive to the sponsors and

legislation in particular jurisdictions may indirectly force the sponsors to follow the project finance route(e.g. where a locally incorporated vehicle must be set up to own the projects assets).



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This is not an exhaustive list, but it is likely that one or more of these reasons will feature in the minds ofsponsors who have elected to finance a project on limited recourse terms.

Project finance, therefore, has many attractions for sponsors. It also has attractions for the hostgovernment. These might include the following:

attraction of foreign investment

acquisition of foreign skills and know-how

reduction of public sector borrowing requirement by relying on foreign or private funding of projects

possibility of developing what might otherwise be non-priority projects and

education and training for local workforce.

1.5 Structuring the project vehicle

One of the first, and most important, issues that the project sponsors will face in deciding how to finance aparticular project will be how to invest in, and fund, the project. There are a number of different structuresavailable to sponsors for this purpose. The most common structures used are:

a joint venture or other similar unincorporated association

a partnership

a limited partnership

an incorporated body, such as a limited company (probably the most common).

Of these structures the joint venture and limited company structure are the most universally used.

A joint venture is a purely contractual arrangement pursuant to which a number of entities pursue a jointbusiness activity. Each party will bring to the project not only its particular expertise but will be responsiblefor funding its own share of project costs, whether from its own revenues or an outside source. Practicaldifficulties may arise as there is no single project entity to acquire or own assets or employ personnel, but

this is usually overcome by appointing one of the parties as operator or manager, with a greater degree ofoverall responsibility for the management and operation of the project. This is the most common structureused in the financing of oil and gas projects in the United Kingdom Continental Shelf.

Partnerships are, like joint ventures, relatively simple to create and operate but in many jurisdictionspartnership legislation imposes additional duties on the partners, some of which (such as the duty to act inthe utmost good faith) cannot be excluded by agreement. Liability is unlimited other than for the limitedpartners in a limited partnership, but these are essentially sleeping partners who provide project capitaland are excluded from involvement in the project on behalf of the firm.

In many cases it will not be convenient (or may not be possible) for the project assets to be held directly(whether by an operator or the individual sponsors) and in these cases it may be appropriate to establish acompany or other vehicle which will hold the project assets and become the borrowing vehicle for theproject. The sponsors will hold the shares in this company or other vehicle in agreed proportions. In mostcases where this route is followed, the company or other vehicle would be a special purpose vehicleestablished exclusively for the purposes of the project and the use of the special purpose vehicle for anypurposes unconnected with the project in question will be published. In addition to the constitutionaldocuments establishing the vehicle, the terms on which it is to be owned and operated will be set out in asponsors or shareholders agreement.

Whether sponsors follow the joint venture (direct investment) route or the special purpose vehicle (indirectinvestment) route ultimately will depend on a number of legal, tax, accounting and regulatory issues, both inthe home country of each of the sponsors and the host country of the project (and, perhaps, other relevantjurisdictions). Some of the relevant influencing factors might include the following:

a wish on the part of the project sponsors to isolate the project (and, therefore, distance themselvesfrom it) in a special purpose vehicle. If the project should subsequently fail, the lenders will have no

recourse to the sponsors, other than in respect of any completion or other guarantees given by thesponsors (see section 6.5 for an explanation of such guarantees). The sponsors are effectively limitingtheir exposure to the project to the value of the equity and/or subordinated debt that they havecontributed to the project



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the use of a joint venture or partnership, as opposed to a special purpose vehicle, can often mean thatthe sponsors must assume joint and several liability when contracting with third parties on behalf of thejoint venture or partnership. If the borrowing for the project is through the joint venture or partnership,this is likely to result in each sponsor having to show the full amount of the project debt on its balancesheet - not a particularly attractive proposition for most project sponsors

by contrast, the use of a special purpose vehicle may mean that the sponsors do not have toconsolidate the project debt into their own balance sheets (if it is not a subsidiary or subsidiary

undertaking or equivalent). This may also be important for cross default purposes for the sponsor. Asponsor would not want a default by a project company (even if it is a subsidiary) to trigger a crossdefault in respect of other contracts or projects at sponsor level. The corporate lenders to the sponsormay agree to this, provided there is no recourse by the projects lenders to the sponsor in the event ofa project company default, eliminating the risk that the project company default will damage or furtherdamage the sponsors balance sheet (note the wide definition of project finance borrowing usedearlier in this section that typically might be used in such a case)

on a similar note, negative pledge covenants in a sponsors corporate loan documentation may prohibitor limit the sponsor from creating the necessary security required in connection with a projectfinancing. As with the cross default clause, the corporate lenders to the sponsor may agree to excludesecurity interests created by the sponsor (or a subsidiary or subsidiary undertaking of the sponsor) inconnection with a specific project from the terms of the sponsors negative pledge

it may be a host government requirement that any foreign investment is channelled through a localcompany, particularly where the granting of a concession might be involved. This may be for regulatoryor tax reasons or, in the case of a strategically important industry, for security or policy reasons

the use of a joint venture or partnership can have significant tax advantages in some jurisdictions (e.g.each participant may be taxed individually and may have the ability to take all tax losses on to its ownbalance sheet) which may make such a vehicle attractive for some sponsors. On the other hand, alimited liability companys profits are in effect taxed twice, once in the hands of the company and againin the hands of the individual shareholders

a special purpose vehicle will be attractive where different sponsors require to fund their investment inthe project in different ways (e.g. one may want to borrow whilst others may wish to fund theinvestment from internal company sources) or one may want to subscribe equity whereas another

might wish to contribute debt (e.g. and subordinate the repayment of this debt to the right of projectlenders) as well and

practical considerations may also be relevant. Partnerships and contractual joint ventures are lesscomplicated (and cheaper) to establish and operate. Registration requirements in respect of limitedcompanies and limited partnerships eliminate confidentiality. It should also be remembered that it iseasier for a company to grant security, in particular floating charges, and this may be an importantconsideration for the raising of finance.

Projects may also be conducted via a European Economic Interest Grouping (EEIG) which is governed by EUregulation and must comprise at least two legal persons from different member states. The purpose of theEEIG is to facilitate or develop the economic activities of its members. It must not make profits for itself. Todate this has not proved a popular vehicle for investing in projects to be financed on limited recourse terms.

In the event, the choice will never be a straightforward one and it is often the case that sponsors will haveconflicting requirements. This will be one of the many challenges for those involved in project financing. Itis, however, important to establish the appropriate vehicle at the outset as it can be difficult to change thevehicle once the project proceeds and, especially, once the funding structure is in place.

1.6 Key sponsor issues

Having settled on the structure of the project vehicle, it will then be necessary for the sponsors to agree atan early stage on a number of other key matters. These will include:

the respective roles in the project of each sponsor (e.g. who will deal with the technical aspects of theproject, negotiate the concession, negotiate with the lenders, arrange the project insurances, negotiatewith suppliers/offtakers, oversee the establishment of the project vehicle, arrange for the necessaryconsents and permits). Frequently the allocation of such tasks will have been dictated already in the

make-up of the sponsor group, but it is important for each sponsor to have a clear understanding at anearly stage what tasks it is to perform



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the appointment of advisers to the project. The two key appointments will be the appointment offinancial and legal advisers to the project. However, other advisers, such as technical, insurance,environmental and market risk advisers, may also be required depending on the circumstances of aparticular project

the capitalisation of the project or project company. How much capital will be put in, when will this beinjected and by what method? There is no hard-and-fast rule for determining how much sponsor capitalmust be injected into a project. Some projects have been structured on the basis that the sponsors

have put up only a nominal amount of capital (called pinpoint capital). More typically, however, onemight expect to see an overall debt/equity ratio in the 90/10 to 75/25 range depending on thedynamics of a particular project. Most lenders will require that sponsor capital is injected at the outset,and before the banks start funding the project company. They may, however, relax this position if theyare satisfied as to the credit standing of the sponsors or have received security (such as a bankguarantee or letter of credit) to secure the sponsors capital commitment. Shareholder funds are usuallyinjected by way of a subscription for shares of the project company, although there is usually noobjection to shareholder loans so long as these are subordinated to the lenders loans and are non-interest bearing (or at least the requirement to pay interest is suspended until dividends are permittedto be paid - see below)

the dividend/distribution policy of the sponsors. This will frequently be a source of much debate withthe project lenders. On the one hand most sponsors will be keen to extract profits at an early stage. Theproject lenders, however, will not be keen to see the sponsors taking out profits until the project hasestablished and proved itself and the project lenders have been repaid at least some of their loans. Itwould be unusual for the project lenders to permit the payment of dividends (or the payment ofinterest on subordinated loans) prior to the date for the first repayment of the project loan and thenonly if the key project cover ratios will be satisfied after the payment of the dividends (see section 8.5for an explanation of key cover ratios)

management of the project vehicle. Who will undertake this and how? Will the project vehicle have itsown employees and management or will these be supplied by one or more of the sponsors? If one ormore of the sponsors is to supply management and/or technical assistance to the project company,then the lenders will expect to see this arrangement formalised in an agreement between the sponsorin question and the project company

sale of shares and pre-emption rights. This will be of concern to sponsors and lenders alike. In particular,

the lenders will want the comfort of knowing that the sponsor group that has persuaded them to lendto the project company in the first place will continue to be in place until they have been repaid in full.

1.7 Project implementation and management

The implementation of a project financing is a complicated, time-consuming and difficult operation. Formost projects it is a case of years rather than months from inception of the project to reach financial close.It is not unheard of for some complex (and perhaps, politically sensitive) projects to have a gestation periodin excess of five years. The chart in Fig. 3 is an illustration of the more important milestones for a typicalproject and how long one might expect the process to take. However, each project will have a uniquetimetable driven largely by the particular dynamics and circumstances of the project.

With so many parties involved having conflicting interests the issue of effective project managementassumes great significance in most project financings. It does not matter whether the overall responsibilityis assumed by the sponsors (and their advisers) or by the lenders (and their advisers). What is crucial,however, is that one of the influential parties assumes overall control for managing the project from itsinception to financial close. Without effective project management, a project can very easily go off the railswith each of the parties singularly concentrating on issues and documents that are relevant to it. Becauseof the need to understand all aspects of the project with a view to assessing the overall risk profile, it isoften the lenders (and their advisers) who are in the best position to manage effectively and steer a projectto financial close.



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Programme for project financing Fig. 3

Project

Test/Event/Milestone

Sponsors approve

Project feasibility

Study

Appoint project

legal counsel and

financial advisor

Appoint other advisors

(e.g. Insurance

environmental)

Agree borrowing

structure

Negotiate additional

equity

Establish project

vehicle

Agree project

documents with

contractors/operators/

suppliers/offtakers

Develop financing

term sheet

Prepare information

memorandum

Select arrangers/

banks

Agree loan

documentation

Agree security and

other documentation

Obtain all consents

and permits for project

Obtain sponsor board/

shareholder approval

Bank's technical

advisor to approve

technical aspects

of project

Bank's insuranceadvisor to approve

project insurances

Agree financial model

Agree legal opinions

Finalise conditions

precendent

Signing and financial

close

First drawdown

1-4 5-8 9-12 13-16

Weeks

17-20 21-24 25-28 29-32 33-36 37-40 41-44 45-48 49-52



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SECTION 2PARTIES TO A PROJECT FINANCING

2.1 Parties and their roles

One of the complicating (and interesting) features of most projects is the considerable number of partieswith differing interests that are brought together with the common aim of being involved to a greater orlesser extent with a successful project. It is one of the challenges of those involved with a project to ensurethat all of these parties can work together efficiently and successfully and co-operate in achieving the

projects overall targets. It is inevitably the case that, although all of the parties will share the same overallaim in ensuring that the project is successful, their individual interests will vary considerably and, in manycases, will conflict. With many projects, there will be an international aspect which will involve differentproject parties located in different jurisdictions and there will often be tensions between laws and practicesdiffering from one country to another.

A common feature in many project structures is that different parties will have particular roles to play. This isespecially so with many multi-sponsor projects where, for example, one sponsor may also be the turnkeycontractor, whereas another sponsor may be the operator and yet another sponsor may be a supplier ofkey raw materials to the project or an offtaker of product from the project. Frequently it is the case (andsometimes this is a requirement of local laws) that one of the sponsors is a local company. Even in thosecountries where the involvement of a local company is not a requirement, this can have many advantagesparticularly where the foreign sponsors have limited experience of business practices or laws in the host

country. Further, the involvement of a local company offers a degree of comfort, for the foreign sponsorsand lenders alike, that the project as a whole will not be unfairly treated or discriminated against.

No two projects will have the same cast of players but the following is a reasonably comprehensive list ofthe different parties likely to be involved in a project finance transaction.

2.2 Project company/borrower

The project company will usually be a company, partnership, limited partnership, joint venture or acombination of them. As noted in section 1.5, this will be influenced to a certain extent by the legal andregulatory framework of the host government. For example, in some jurisdictions it will be a legalrequirement that the holder of a licence or concession must be a company incorporated in that particularcountry. In other countries, for example, there may be strict requirements in particular industries as toforeign ownership of share capital or assets, particularly in strategically important industries.

The project company will in most cases be the vehicle that is raising the project finance and, therefore, willbe the borrower. It will also usually be the company that is granted the concession or licence (in aconcession-based financing) and who enters into the project documents. As has been seen in section 1,the project company is frequently a special purpose vehicle set up solely for the purposes of participating ina particular project. If the project vehicle is a joint venture then it is likely that there will be multipleborrowers and this can complicate the financing arrangements unless (as is likely to be the preference ofthe lenders) the joint venturers agree to be jointly and severally liable for the projects debts. Where,however, the borrower is a special purpose vehicle, then the lenders would expect a newly incorporatedcompany in the relevant jurisdiction and would seek to impose strict covenants on the ability of theborrower to undertake any non-project activities. The purpose of this is to ensure that the lenders are notexposed to any additional risks unrelated to the project itself. An example of the type and scope of suchcovenants is set out in Fig. 4.



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2.3 Sponsors/shareholders

The project sponsors are those companies, agencies or individuals who promote a project and bringtogether the various parties and obtain the necessary permits and consents necessary to get the projectunder way. As has been noted in section 1, often they (or one of their associated companies) are involvedin some particular aspect of the project, for example, the construction, operation and maintenance,purchase of the services or output from the project or ownership of land related to the project. They areinvariably investors in the equity of the project company and may be debt providers or guarantors ofspecific aspects of the project companys performance. Some of the different ways in which thesponsors/shareholders invest in a project is explained in section 1.5.

The support provided by project sponsors varies from project to project and includes the giving of comfortletters, cash injection commitments, both pre- and post-completion, as well as the provision of completionsupport through guarantees and the like. Support is also likely to extend to providing management andtechnical assistance to the project company. The different types of sponsor support for a project arecovered in more detail in section 6.

Single purpose vehicle covenants Fig. 4

The Project Company shall not:

engage in any business or activity, apart from the ownership, management and operation of theProject and activities ancillary thereto as permitted by this Agreement and the Security Documentsor

save as contemplated in the Security Documents, create, incur or permit to subsist any SecurityInterest over all or any of its present or future assets, other than any Security Interest arising byoperation of law and discharged within 30 days or

make any advances, grant any credit (save in the routine course of its day-to-day business) or giveany guarantee or indemnity to, or for the benefit of, any person or otherwise voluntarily assumeany liability, whether actual or contingent, in respect of any obligation of any other person, exceptpursuant to the Security Documents or

issue any further shares (other than to an existing direct or indirect shareholder) or alter any rightsattaching to its issued share capital in existence at the date hereof or

save in accordance with the terms of this Agreement and the Security Documents, sell, lease,

transfer or otherwise dispose of, by one or more transactions or series of transactions (whetherrelated or not), the whole or any part of its assets or

incur any indebtedness other than the Project Loan, unless such indebtedness is subordinatedboth in terms of payment and security to the satisfaction of the Project Lenders to all amounts dueunder this Agreement or

save in accordance with the terms of this Agreement and the Security Documents, acquire anyasset or make any investment or

amend its constitutional documents or

change its financial year.



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2.4 Third-party equity

These are investors in a project who invest alongside the sponsors. Unlike the sponsors, however, theseinvestors are looking at the project purely in terms of a return on their investments for the benefit of theirown shareholders. Apart from providing their equity, the investors generally will not participate in the projectin the sense of providing services to the project or being involved in the construction or operating activities.

Third-party investors typically will be looking to invest in a project on a much longer time frame ascompared with, say, a typical contractor sponsor, who will in most cases want to sell out once theconstruction has been completed.

Many third-party investors are development or equity funds set up for the purposes of investing in a widerange of projects and they are starting to become a valuable source of capital for projects. Typically, theywill require some involvement at board level to monitor their investment.

Third-party investors are becoming a feature of United Kingdom PFI projects where the United KingdomGovernment is actively encouraging this type of participation in such projects.

2.5 Banks

The sheer scale of many projects dictates that they cannot be financed by a single lender and, therefore,syndicates of lenders are formed in a great many of the cases for the purpose of financing projects. In aproject with an international dimension, the group of lenders may come from a wide variety of countries,perhaps following their customers who are involved in some way in the project. It will almost certainly bethe case that there will be banks from the host country participating in the financing. This is as much forthe benefit of the foreign lenders as a desire to be involved on the part of the local lenders. As with theinvolvement of local sponsors, the foreign lenders will usually take some comfort from the involvement oflocal lenders.

As is usually the case in large syndicated loans, the project loan will be arranged by a smaller group ofarranging banks (which may also underwrite all or a portion of the loan). Often the arranging banks are theoriginal signatories to the loan agreement with the syndication of the loan taking place at a later date. In

Com

mercial

banks

Multila

terals

/Expor

t

Credit

Agenci

es

Key project parties Fig. 5

SPV

SPONSOR

S

LENDER

S

INSURERS

CONTRACTOR/

HOSTGOVERNMENT

P

ROFESS

IONALS

BOND

ISSUERS

PURCHASER SUPPLIER

OPER

ATOR

Spon

sor

A

Sponsor

B SponsorC

DESIGNER

EXPERTS/

PER

FORM

ANCE



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such cases the arranging banks implicitly take the risk that they will be able to sell down the loan at a laterstage.

However, participating in project financings is a very specialised area of international finance and the actualparticipants tend to be restricted to those banks that have the capability of assessing and measuringproject risks. This is not to say that banks not having these skills do not participate in project financings, butfor these banks the risks are greater as they must also rely on the judgement of the more experiencedbanks.

The complexity of most project financings necessitates that the arrangers are large banks with experiencein this market, often having dedicated departments of specialists. For the smaller banks with an appetite forthis kind of lending, however, there is usually no shortage of opportunities to participate in loans arrangedby the larger banks.

2.6 Facility agent

As with most syndicated loans, one of the lenders will be appointed facility agent for the purposes ofadministering the loan on behalf of the syndicate. This role tends to assume an even greater significance inproject financings as inevitably there are more administration matters that need undertaking. Usually,however, the role of the facility agent will be limited to administrative and mechanical matters as the facilityagent will not want to assume legal liabilities towards the lenders in connection with the project. Thedocumentation will, therefore, establish that the facility agent will act in accordance with the instructions ofthe appropriate majority (usually 66 2/3 per cent) of the syndicate who will vote and approve the variousdecisions that need to be taken throughout the life of a project. The documentation, however, may reservefor the facility agent some relatively minor discretions to avoid delays for routine consents and approvals.

2.7 Technical bank

In many project financings a distinction is drawn between the facility agent (who deals with the moreroutine day-to-day tasks under the loan agreement) and a bank appointed as technical bank which will dealwith the more technical aspects of the project loan. In such cases it would be the technical bank that wouldbe responsible for preparing (or perhaps reviewing) the banking cases and calculating the cover ratios (seesection 8.5 for a more detailed explanation of cover ratios). The technical bank would also be responsiblefor monitoring the progress of the project generally on behalf of the lenders and liaising with the externalindependent engineers or technical advisers representing the lenders. It will almost always be the case thatthe technical bank will be selected for its special ability to understand and evaluate the technical aspects ofthe project on behalf of the syndicate.

As with the facility agent, the technical bank will be concerned to ensure that it is adequately protected inthe documentation and will be seeking to minimise any individual responsibility to the syndicate for its roleas technical bank.

2.8 Insurance bank/account bank

In some of the larger project financings additional roles are often created for individual lenders, sometimesfor no other reason than to give each of the arranging banks a meaningful individual role in the projectfinancing. Two of these additional roles are as insurance bank and as account bank.

The insurance bank, as the title suggests, will be the lender that will undertake the negotiations inconnection with the project insurances on behalf of the lenders. It will liaise with an insurance adviserrepresenting the lenders and its job will be to ensure that the project insurances are completed anddocumented in a satisfactory manner and that the lenders interests are observed.

The account bank will be the lender through whom all the project cash flows flow. There will usually be adisbursement account to monitor disbursements to the borrower and a proceeds account into which allproject receipts will be paid. Frequently, however, there will be a number of other project accounts to dealwith specific categories of project receipts (e.g. insurances, liquidated damages, shareholder payments,maintenance reserves, debt service reserves). A more detailed description of the project accounts and theiroperation is set out in section 8.2.

2.9 Multilateral and export credit agencies

Many projects are co-financed by the World Bank or its private sector lending arm, the International FinanceCorporation (IFC), or by regional development agencies, for instance, the European Bank for Reconstructionand Development (EBRD), the African Development Bank or the Asian Development Bank.



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These multilateral agencies are able to enhance the bankability of a project by providing internationalcommercial banks with a degree of protection against a variety of political risks, including the failure of hostgovernments to make agreed payments or to provide foreign exchange, as well as the failure of the hostgovernment to grant necessary regulatory approvals or to ensure the performance of certain participants ina project.

Export credit agencies also play a very important role in the financing of infrastructure and other projects inemerging markets. As their name suggests, the role of the agencies is to assist exporters by providing

subsidised finance either to the exporter direct or to importers (through buyer credits). Details of the variousmultilateral agencies and ECAs and a description of the type of financing support they each provide inrelation to projects are set out in section 10.

2.10 Construction company

In an infrastructure project the contractor will, during the construction period at least, be one of the keyproject parties. Commonly, it will be employed directly by the project company to design, procure, constructand commission the project facility assuming full responsibility for the on-time completion of the projectfacility - this is usually referred to as the turnkey model.

The risks associated with the construction phase are discussed in more detail in section 3.4. The contractorwill usually be a company well known in its field and with a track record for constructing similar facilities,ideally in the same part of the world. In some large infrastructure projects a consortium of contractors isused. In other cases an international contractor will join forces with a local contractor. In each of thesecases one of the issues that will be of concern to both the project company and the lenders is whether thecontractors in the joint venture will assume joint and several liability or only several liability under theconstruction contract. This may be dictated by the legal structure of the joint venture itself (e.g. whether itis an unincorporated association or a true partnership - see section 1.5 for a discussion of the keydifferences). Lenders, for obvious reasons, will usually prefer joint and several liability.

Although most projects are structured on the basis that there will be one turnkey contractor, some projectsare structured on the basis that a number of companies are employed by the project company to carry outvarious aspects of the design, construction and procurement process which are carried out under theoverall project management of either the project company or a project manager. This is not a structurefavoured by lenders as it can lead to gaps in responsibilities for design and construction. Lenders will alsousually prefer that the project company divests itself of responsibility for project management and that thisis assumed by a creditworthy entity against whom recourse may be had if necessary. This is discussed

further in section 5.3.

2.11 Operator

In most infrastructure projects, where the project vehicle itself is not operating (or maintaining) the projectfacility, a separate company will be appointed as operator once the project facility has achieved completion.This company will be responsible for ensuring that the day-to-day operation and maintenance of theproject is undertaken in accordance with pre-agreed parameters and guidelines. It will usually be a companywith experience in facilities management (depending upon the particular project) and may be a companybased in the host country. Sometimes one of the sponsors will be the operator as this will often be theprincipal reason why that sponsor was prepared to invest in the project.

As with the contractor, the lenders will be concerned as to the selection of the operator and will want toensure that the operator not only has a strong balance sheet but also has a track record of operating similartypes of projects successfully.

The contractor and operator are not usually the same company as very different skills are involved.However, both play a very key role in ensuring the success of a project.

2.12 Experts

These are the expert consultancies and professional firms appointed by the lenders to advise them oncertain technical aspects of the project. (The sponsors will frequently also have their ownconsultants/professionals to advise them.) The areas where lenders typically seek external specialist adviceare on the technical/engineering aspects of projects as well as insurances and environmental matters.Lenders will also frequently turn to advisers to assist them in assessing market/demand risk in connectionwith the project.

Each of these consultancies/professional firms will be chosen for its expertise in the particular area and will

be retained to provide an initial assessment prior to financial close and, thereafter, on a periodic basis. Animportant point to note is that these consultancies/professional firms are appointed by (and thereforeanswerable to) the lenders and not the borrower or the sponsors. However, the cost of theseconsultants/professional firms will be a cost for the project company to assume and this can be a cause of



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friction. It is usual, therefore, for a fairly detailed work scope to be agreed in advance between the lenders,the expert and the sponsors.

2.13 Host government

As the name suggests this is the government in whose country the project is being undertaken. The role ofthe host government in any particular project will vary from project to project and in some developingcountries the host government may be required to enter into a government support agreement (seesection 6.7). At a minimum, the host government is likely to be involved in the issuance of consents and

permits both at the outset of the project and on a periodic basis throughout the duration of the project. Inother cases, the host government (or an agency of the host government) may actually be the purchaser orofftaker of products produced by the project and in some cases a shareholder in the project company(although not usually directly but through government agencies or government controlled companies). It isusually the case that the host government will be expected to play a greater role in project financing(whether in providing support, services or otherwise) in the lesser developed and emerging countries.

Whatever the actual level of involvement the host government of a particular country plays in projectfinancings, its general attitude and approach towards foreign financed projects will be crucial in attractingforeign investment. If there has been any history of less than even-handed treatment of foreign investors orgenerally of changing the rules, then this may act as a serious block on the ability to finance projects in thatcountry on limited recourse terms.

2.14 Suppliers

These are the companies that are supplying essential goods and/or services in connection with a particularproject. In a power project, for example, the fuel supplier for the project will be one of the key parties. Inother projects, a particular supplier may be supplying equipment and/or services required either during theconstruction or the operating phase of the project. Both the contractor and the operator would also fallunder this category. Many of the comments made with respect to the contractor and the operator will alsoapply to the suppliers. However, it is not always the case that the suppliers (and for that matter thepurchasers) are as closely tied into a project structure as, say, the contractor and operator, with the resultthat the lenders may not therefore be in a position to dictate security terms to them to the same extent.

Where there is no long-term supplier of essential goods and/or services to a project then both lenders andthe project company are necessarily taking the risk that those supplies will be available to the project insufficient amounts and quality, and at reasonable prices.

2.15 PurchasersIn many projects where the projects output is not being sold to the general public, the project company willcontract in advance with an identified purchaser to purchase the projects output on a long-term basis. Forexample, in a gas project there may be a long-term gas offtake contract with a gas purchaser. Likewise in apower project the purchaser/offtaker may be the national energy authority who has agreed to purchasethe power from the plant. However, it is not always the case that there is an agreed offtaker and in someprojects (such as oil projects) there will be no pre-agreed long-term offtake contract, rather the products willbe sold on the open market and to this extent the banks will take the market risk.

In some projects essential supplies to the project (such as fuel) and the projects output (e.g. electricity) arepurchased by the project company or, as the case may be, sold on take-or-pay terms, that is thepurchaser is required to pay for what it has agreed to purchase whether or not it actually takes delivery.This type of contact is discussed in more detail in section 3.4.

2.16 Insurers

Insurers play a crucial role in most projects. If there is a major catastrophe or casualty affecting the projectthen both the sponsors and the lenders will be looking to the insurers to cover them against loss. In a greatmany cases if there was no insurance cover on a total loss of a facility then the sponsors and lenders wouldlose everything. Lenders in particular, therefore, pay close attention not only to the cover provided but alsoto who is providing that cover. Most lenders will want to see cover provided by large international insurancecompanies and will be reluctant to accept local insurance companies from emerging market countries.

In some industries (e.g. the oil industry) some of the very large companies have set up their own offshorecaptive insurance companies, either for their own account or on a syndicate basis with other largecompanies. This is, in effect, a form of self-insurance and lenders will want to scrutinise such arrangementscarefully to ensure that they are not exposed to any hidden risks.

In other cases, insurance cover for particular risks either may not be available or may be available only atprohibitive premiums or from insurers of insufficient substance or repute. In such cases the lenders willwant to see that alternative arrangements are made to protect their interests in the event of a majorcatastrophe or casualty.



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These and other insurance issues are examined in more detail in section 7.

2.17 Other parties

There will be other parties such as financial advisers, rating agencies, local/regional authorities, accountants,lawyers and other professionals that have a role to play in many projects to add to the complexity. Add tothis the fact that very often each of these parties will have their own separate legal and tax advisers and itcan be seen that the task of legal co-ordination of these projects can (and frequently is) a difficult, timeconsuming and expensive process. This makes effective project management of the project an essential

and key part of the success of the implementation of a project (see section 1.7).

2.18 Summary of key lenders concerns

Before agreeing to lend to a particular project, the lenders will pay particular attention to each of the partiesthat will have an involvement (however small) in the project, whether at the inception of the project, duringthe construction phase or during the operating phase. It is not an exaggeration to say that, in the case ofmany project financings, the robustness of the overall project structure is only as strong as its weakest link.The following are some of the key issues that the lenders will focus on:

the creditworthiness of the parties and, in particular, whether they have sufficient financial resources tomeet their obligations under the relevant project documents. If the lenders are not so satisfied, thenthey are likely to call for guarantees or letters of credit from parent companies or other banks andfinancial institutions to support these obligations

equally important is the ability of the parties to deliver and perform according to the specifications ofthe project documents. Do the parties have sufficient technical and management resources? Have theyexperience of similar projects in similar circumstances? Have they undertaken similar arrangements inthe relevant country? These are all issues that the lenders will ask themselves before committing to aparticular project

what, if any, relationship does a particular pr